Leveraged recapitalization 101

Deciding to sell all or part of your company is no easy decision. Many small business owners who have built a successful company are often torn between taking chips off the table and pushing harder to take their company to the next level of success.

Growing the company further would have a greater payoff when the owner finally does decide to exit, but there is no guarantee. Currently rosy business conditions can change quickly. The owner may need more capital to grow the business, yet he may not wish to personally guarantee more debt. And if the company experiences tough times, it will be worth less tomorrow after investing more equity and time in the venture. The question boils down to this — do you sell the company now while times are good, or do you hang on and bet that things will continue to get better, perhaps borrowing funds to grow even faster while the opportunity is there?

There is a potential answer to the question that lies in the middle. It is an option that allows the owner of a successful company to mitigate his overall business risk and take some money for his family now, but still allows him to see out the growth of the firm he started. Further, he can be absolved of any personal guarantee on any existing debt and future debt secured to grow the business.

It is like getting two bites at the apple — enjoy some of the fruit now, but continue to grow the fruit larger and sweeter, and eat again later. The scenario is called a leveraged recapitalization or leveraged buyout, sometimes referred to as an LBO.

The scenario generally works like this:

First, the owner will sell a majority interest in the company to an investment group, typically a financial buyer who may have deep general business expertise, but no specific expertise in the subject business. The advantage of a financial buyer as a partner is that the original owner is usually left “in charge” of the operation. The investment group doesn’t really know the business; they just like the way you have run it in the past, or they wouldn’t have made the investment.

Also, the owner will get some sort of “premium” for the part of the business sold. Typically, he may get 70-75 percent of the company’s value in exchange for 51 percent of the stock. This “funny” math can work because the investment group brings in banks or lenders that are part of this total recapitalization package. The minority interest in a smaller privately held company is not worth as much on a pro-rata basis until that interest is sold.

Now the owner has a deep-pocketed partner with lots of business acumen. This partner is in the business of making money and will make sure the owner has the resources, investment and business plan necessary to grow the firm accordingly. The typical goal is to triple (or more) the value of the company and sell to another group.

This second sale is the proverbial second bite at the apple. The 49-percent original owner will participate in the sale of a company at least three times as large as the original business. Ultimately he gets much more money for his equity than an outright sale might have garnered; he gets to mitigate his risk by taking money off the table much earlier in the process, and during the interim, he gets to make a very comfortable living running the company he began.

If you would like a more detailed description and a personalized forecast of how a leveraged recapitalization would look for your business, please contact Thomas Brinsko or John Zapalac at (281) 538-9996.

Leveraged Recapitalization: Top 5 Benefits to the Owner/Seller

1.Pull 70 percent of value from firm and still own 49 percent of the company.

2.Owner will have investment group as partner going forward. They bring general business expertise and deep pockets for future growth.

3.Despite minority position, owner typically still “in charge” of operation as investment group usually likes the way it is run or they wouldn’t invest.

4.Owner does not personally guarantee any new debt and his guarantee is removed from any existing debt.

5.Because owner still has 49 percent, he can get a “second bite at the apple” when he grows business further with investment group and they sell down the road. Owner’s exit strategy may be negotiated as part of first deal.